Question

As a financial adviser to individual investors, your boss has asked you to write a memo to him so that he can recommend a mortgage-backed bond to a client. The client has a particular corporate bond in mind, but your boss thinks that a pass-through mortgage-backed security would provide a better yield at the same risk level and maturity. The bond that the client is considering is a 7-year, AA-rated bond with a 6.75% coupon. When it matures, the proceeds will be used for and are matched exactly with the cost of his daughter’s college education, which will be paid in one lump sum. The bond your boss favors is a pass-through MBS (also 7-year with an AA rating), featuring a 7.15% coupon. Your economic research department just released a research report that predicts that interest rates are going to decline over the next several years to historical lows. 

Write a memo to your boss of at least 300 words that provides the following:

Your recommendation

At least 3 reasons you considered to develop your recommendation

As a financial adviser to individual investors, your boss has asked you to write a memo to him so that he can recommend a mortgage-backed bond to a client. The client has a particular corporate bond in mind, but your boss thinks that a pass-through mortgage-backed security would provide a better yield at the same risk level and maturity. The bond that the client is considering is a 7-year, AA-rated bond with a 6.75% coupon. When it matures, the proceeds will be used for and are matched exactly with the cost of his daughter’s college education, which will be paid in one lump sum. The bond your boss favors is a pass-through MBS (also 7-year with an AA rating), featuring a 7.15% coupon. Your economic research department just released a research report that predicts that interest rates are going to decline over the next several years to historical lows. 

Write a memo to your boss of at least 300 words that provides the following:

Your recommendation

At least 3 reasons you considered to develop your recommendation

Answer 1

Example of a memo

To: name of the boss and his designation

prepared by: your name and designation

sub: a recommendation as to which bond should be chosen for investment

recommendation:

Given the client profile and his investment goal, it is recommended that he should choose corporate bond for investment.underlying reasons for this recommendation are given below:

1) MBS is a derivative security whose underlying is home loans so if the underlying performs well then only derivative will perform well so if the retail borrowers default in their EMI it impact the cash flows of MBS, though the Credit rating of MBS is AA ,but it does not guarantee the creditworthiness of all retail borrowers on the other the AA rating of a corporate guarantee this creditworthiness of the corporate issuer who is the sole borrower.thus the credit risk of MBS is higher than the corporate bond

2) As the economic research shows the interest rates are going to be down in next several years. which can make the retail borrowers to refinance their loan that is they will repay their existing loans which are at higher interest rate by borrwing at lower interest rates which will impact the overall MBS performance including the cashflows depending upon the tranch. this is not the case with corporate bond since it is not callable bond issuer cannot buy it back before maturity which means that cashflows certain to receive.so MBS also has prepayment risk.

3) As the objective of the investor is to finance his daughter's college studies 7 years hence from now and one of the properties of corporate bond allows for this which is, at maturity. what the investor will get is last coupon payment and face value of bond hence client can as much bonds of particular FV as the amount studies is estimated for example if a 100 dollar corporate bond is being traded at 65 and estimated college study fees would be 60000 dollars hence investor can buy 600 bonds by paying 65*600=39000 dollars this cannot be said for MBS with certainty because of risks discussed above.